I HOLD THIS TRUTH TO BE SELF-EVIDENT, THAT A DEBT CRISIS CANNOT BE RESOLVED WITH MORE DEBT

Monday, December 15, 2008

Margin Debt

The amount of margin debt as reported by NYSE has plunged to $233 billion in October (latest figures available) from a high of $381 billion reached in July 2007. It's pretty certain that it has declined even further in the last 1 1/2 months, given the recent performance of markets.

I must caution that we live in the Age of Derivatives and therefore speculative leverage can be taken on in many more ways than plain old margin debt (e.g. CDS). Still, there is no question that de-leveraging is happening very fast.

16 comments:

All those CDS buyers whose positions are being backstopped by the govt are going to have a ton of unencumbered cash over the next 12-18mos and what they do with it will decide which way prices swing. Several trillion $ of liquidity can't not have a major effect when it is deployed.

Hell, please avoid Seeking Alpha at all costs. Mish and TBP's Barry Ritholz have both had no end of headache associated with that organization. They will change your work deliberately, misquote you wherever possible, and tell you all these shenanigans add value.

Given the asian currency swaps i.e China, S Korea, Japan and our current fund rate have they opened a segement to the reality to let exchange rates flow to stabilize as to trust as unity to reason, hence "Capitalism was aptly defined by the great Austrian economist Joseph Schumpeter as a system of ‘creative destruction’. Its instruments are entrepreneurs." They and the institutions through which they operate or, I assume value exchange to commonality? The past as such was "The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion,or later as a final and total catastrophe of the currency system involved as observed. Ludwig Von MISESMy friend in China understood clearly as i did when we discussesd this in the tech bubble we averted to preserve capital then. When have these cultures cooperated to this extent as we know the historical context of them. They look at time frames different than the west and cleary want to avert social acrimony. IMO

Much of that margin was leverage that went poooof. credit liquidity that was used to jack up futures market's both stock and commodity has hit the escape button and disappeared. The credit manufacturing machine known as American finance innovation has crashed and along with it goes inflated assets that have been pumped for many years with more and more leverage.

It would be nice to see a historical graph of margin debt mapped as a function of account value. What you've posted looks like a bubble breaking, and probably is to an extent, but it would be more meaningful if we had that context.

Much of the drop in margin debt was caused by forced liquidation in the October market crash.

I have second hand experience with this: a friend of mine had a very conservative portfolio, and even so his positions were squeezed. The market fell so far so fast that almost all of his investments (whether or not they had been bought on margin) had to be liquidated to prevent massive margin calls.

There was nothing wrong really with his portfolio, and not all of it had been built with margin. Nevertheless, he said he had to sell good positions to close out margin positions.

Speaking of crashes... the major debt instrument that has yet to explode is the synthetic collateralised debt obligation (synthetic CDO, or SCDO). These suckers are both the most fanciful of the instruments, and one of the largest at $50 trillion. Below is an excellent article about SCDOs:

Touché, Old Trader, touché. I agree -- and he does now, too -- that using margin automatically destroys 'conservative investment.'

I revise my comment to: 'more conservative and less speculative than what was common.' However, even though he lost his margin account, he still made more money than the margin ended up costing him.

His investment core survived (about half his peak net worth, and not bought on margin), but the other half vanished into money heaven. From my reading, that is fairly common. Do you, Trader, have any observations on that?

About Me

I was educated as a chemical engineer but spent almost my entire career in finance, particularly in money, FX and bond markets. The name stands for Hell-as-IOUs and the picture points to Quixotic endeavors.